currency exchange rate

The European Exchange Rate Mechanism (or ERM) was a system introduced by the European Community in March 1979, as part of the European Monetary System (EMS), to reduce exchange rate variability and achieve monetary stability in Europe, in preparation for Economic and Monetary Union and the introduction of a single currency, the euro, which took place on 1 January 1999.

Intent and operation of the ERM

The ERM is based on the concept of fixed currency exchange rate margins, but with exchange rates variable within those margins. Before the introduction of the euro, exchange rates were based on the ECU, the European unit of account, whose value was determined as a weighted average of the participating currencies.

A grid (known as the Parity Grid) of bilateral rates was calculated on the basis of these central rates expressed in ECUs, and currency fluctuations had to be contained within a margin of 2.25% on either side of the bilateral rates (with the exception of the Italian lira, which was allowed a margin of 6%). Determined intervention and loan arrangements protected the participating currencies from greater exchange rates fluctuations.

The Irish pound loses parity with Pound Sterling

Ireland's participation in ERM resulted in the Irish pound breaking parity with the Pound Sterling in 1979 as very shortly after the launch of the ERM the Pound Sterling, not at the time an ERM currency, appreciated against all ERM currencies and continued parity would have taken the Irish pound outside of its agreed band.

Pound Sterling's forced withdrawal from the ERM

The United Kingdom entered the ERM in 1990, but was forced to exit the programme in 1992 after the Pound Sterling came under major pressure from currency speculators, including George Soros. The ensuing crash of 16 September 1992, was subsequently dubbed "Black Wednesday". There has been some revision of attitude towards this event given the UK's strong economic performance since 1992, with some commentators dubbing it "White Wednesday". Some commentators took to referring to ERM as an "Eternal Recession Mechanism", after the UK fell into recession during the early 1990s.

Increase of margins

In 1993, the margin had to be expanded to 15% to accommodate speculation against the French franc and other currencies.

Replacement with the euro and ERM II

On December 31, 1998, the ECU exchanges rates of the Eurozone countries were frozen and the value of the euro, which then superseded the ECU at par, was thus established.

In 1999, ERM II replaced the original ERM. The Greek and Danish currencies were part of the system, but as Greece joined the euro in 2001, the Danish krone was left as the only participant member. Currencies in ERM II are allowed to float within a range of ±15% with respect to a central rate against the euro. In the case of the krone, the Danish Central Bank keeps the exchange rate within the narrower range of ± 2.25% against the central rate of EUR 1 = DKK 7.460 38.

Current status of the ERM II

As of 1 May 2004, the ten National Central Banks (NCBs) of the new member countries became party to the ERM II Central Bank Agreement. The national currencies themselves will become part of the ERM II at different dates, as mutually agreed.

The Estonian kroon, Lithuanian litas, and Slovenian tolar were included in the ERM II on 28 June 2004; the Cypriot pound, the Latvian lats and the Maltese lira on 2 May 2005; the Slovak koruna on 28 November 2005^[1]. The currencies of the three largest countries which joined the European Union on 1 May 2004 (the Polish zloty, the Czech koruna, and the Hungarian forint) are expected to follow eventually.

EU countries that have not adopted the euro are expected to participate for at least two years in the ERM II before joining the Eurozone.

Exchange rate bands

See also

• European Monetary System
• Currencies related to the euro
• Stability and Growth Pact

References

1. ^ European Central Bank

External links

• European Central Bank press releases:
• On inclusion of the 10 new NCBs
• On inclusion of the Slovenian tolar
• On inclusion of the Lithuanian litas
• On inclusion of the Estonian kroon
• On inclusion of the Latvian lats
• On inclusion of the Cyprus pound
• On inclusion of the Maltese lira
• On inclusion of the Slovak koruna

Articles

• Guardian Unlimited | Special reports | Pound drops out of ERM - September 17, 1992